HIER 2005 Abstracts

2056. Robert M. Anderson, Glenn Ellison, and Drew Fudenberg
Location Choice in Two-Sided Markets with Indivisible Agents
Abstract | Paper
Consider a model of location choice by two sorts of agents, called “buyers”and “sellers:”In the first period agents simultaneously choose between two identical possible locations; following this, the agents­ at each location play some sort of game with the other agents there. Buyers prefer locations with fewer other buyers and more sellers, and sellers have the reverse preferences. We study the set of possible equilibrium sizes for the two markets, and show that two markets of very different sizes can co-exist even if larger markets are more efficient. This extends the analysis of Ellison and Fudenberg [3] (EF), who ignored the constraint that the number of agents of each type in each market should be an integer, and instead analyzed the “quasi-equilibria”where agents are treated as infinitely divisible.

2057. N. Gregory Mankiw and Matthew Weinzierl
Dynamic Scoring: A Back-of-the-Envelope Guide
Abstract | Paper
This paper uses the neoclassical growth model to examine the extent to which a tax cut pays for itself through higher economic growth. The model yields simple expressions for the steady-state feedback effect of a tax cut. The feedback is surprisingly large: for standard parameter values, half of a capital tax cut is self-financing. The paper considers various generalizations of the basic model, including elastic labor supply, departures from infinite horizons, and non-neoclassical production settings. It also examines how the steady-state results are modified when one considers the transition path to the steady state.

2058. George-Marios Angeletos and Laurent-Emmanuel Calvet
Incomplete Market Dynamics in a Neoclassical Production Economy
Abstract | Paper
We investigate a neoclassical economy with heterogeneous agents, convex technologies and idiosyncratic production risk. Combined with precautionary savings, investment risk generates rich effects that do not arise in the presence of pure endowment risk. Under a finite horizon, multiple growth paths and endogenous fluctuations can exist even when agents are very patient. In infinite-horizon economies, multiple steady states may arise from the endogeneity of risk-taking and interest rates instead of the usual wealth effects. Depending on the economy’s parameters, the local dynamics around a steady state are locally unique, totally unstable or locally undetermined, and the equilibrium path can be attracted to a limit cycle. The model generates closed-form expressions for the equilibrium dynamics and easily extends to a variety of environments, including heterogeneous capital types and multiple sectors.

2059. Ulrich Doraszelski and Kenneth L. Judd
Avoiding the Curse of Dimensionality in Dynamic Stochastic Games
Abstract | Paper
Discrete-time stochastic games with a finite number of states have been widely ap- plied to study the strategic interactions among forward-looking players in dynamic en- vironments. However, these games suffer from a "curse of dimensionality" since the cost of computing players' expectations over all possible future states increases exponentially in the number of state variables. We explore the alternative of continuous-time stochas- tic games with a finite number of states, and show that continuous time has substantial computational and conceptual advantages. Most important, continuous time avoids the curse of dimensionality, thereby speeding up the computations by orders of magnitude in games with more than a few state variables. Overall, the continuous-time approach opens the way to analyze more complex and realistic stochastic games than currently feasible.

2060. David Cutler and Edward Glaeser
What Explains Differences in Smoking, Drinking and Other Health-Related Behaviors?
Abstract | Paper
We explore economic model of health behaviors. While the standard economic model of health as an investment is generally supported empirically, the ability of this model to explain heterogeneity across individuals is extremely limited. Most prominently, the correlation of different health behaviors across people is virtually zero, suggest that standard factors such as variation in discount rates or the value of life are not the drivers of behavior. We focus instead on two other factors: genetics; and behavioral-specific situational factors. The first factor is empirically important, and we suspect the second is as well.

2061. Edward L. Glaeser, Joseph Gyourko and Raven E. Saks
Why Have Housing Prices Gone Up?
Abstract | Paper
Since 1950, housing prices have risen regularly by almost two percent per year. Between 1950 and 1970, this increase reflects rising housing quality and construction costs. Since 1970, this increase reflects the increasing difficulty of obtaining regulatory approval for building new homes. In this paper, we present a simple model of regulatory approval that suggests a number of explanations for this change including changing judicial tastes, decreasing ability to bribe regulators, rising incomes and greater tastes for amenities, and improvements in the ability of homeowners to organize and influence local decisions. Our preliminary evidence suggests that there was a significant increase in the ability of local residents to block new projects and a change of cities from urban growth machines to homeowners’ cooperatives.

2062. Edward L. Glaeser, Joseph Gyourko and Raven E. Saks
Urban Growth and Housing Supply
Abstract | Paper
Cities are physical structures, but the modern literature on urban economic development rarely acknowledges that fact. The elasticity of housing supply helps determine the extent to which increases in productivity will create bigger cities or just higher paid workers and more expensive homes. In this paper, we present a simple model that provides a framework for doing empirical work that integrates the heterogeneity of housing supply into urban development. Empirical analysis yields results consistent with the implications of the model that differences in the nature of house supply across space are not only responsible for higher housing prices, but also affect how cities respond to increases in productivity.

2063. Marianne Bertrand and Sendhil Mullainathan
Profitable Investments or Dissipated Cash?: Evidence on the Investment-Cash Flow Relationship From Oil and Gas Lease Bidding
Abstract | Paper
Both agency- and non-agency-based interpretations have been proposed to explain the strong positive empirical relationship between corporate cash flow and corporate investment. In this paper, we attempt to distinguish between these different interpretations using project-level data in the oil and gas industry. The specific projects we consider are mineral exploration leases on tracts of land. The standard positive relationship between investment and cash flow holds for these projects, in that we find that positive shocks to residual cash flow (netting out firm and time effects) are associated with higher spending on these projects. Interestingly, the increased investment comes from an increase in the price paid per tract with little to no change in the total number of tracts or total acreage of land bought. The positive association between price and cash flow holds even after controlling for a set of tract and firm characteristics that might be ex-ante related to expected return on a given tract. This data is most useful, however, because we can directly observe the eventual productivity of the projects undertaken. We find that the variation in bid price induced by higher cash flow is, if anything, negatively related to tract productivity. More importantly, the overall number of productive tracts does not increase with the cash flow in the year these tracts were bought. In other words, while higher cash flow is associated with higher spending on these projects, higher cash flow does not lead to higher revenues from these projects. Combining this finding with the lack of a quantity response, we conclude that our results are best described by an agency model where managers use cash flow to simplify their job (or live a “quiet life”) rather than “empire-build.”

2064.Eddie Dekel, Drew Fudenberg and Stephen Morris
Interim Rationalizability
Abstract | Paper
This paper proposes the solution concept of interim rationalizability, and shows that all type spaces that have the same hierarchies of beliefs have the same set of interim rationalizable outcomes. This solution concept characterizes common knowledge of rationality in the universal type space.

2065. Philippe Aghion, Alberto Alesina and Francesco Trebbi
Choosing Electoral rules: Theory and Evidence from US Cities
Abstract | Paper
This paper studies the choice of electoral rules, in particular the question of minority representation. Majorities tend to disenfranchise minorities through strategic manipulation of electoral rules. With the aim of explaining changes in electoral rules adopted by US cities (particularly in the South), we show why majorities tend to adopt ”winner-take-all” citywide rules (at-large elections) in response to an increase in the size of the minority when the minority they are facing is relatively small. In this case, for the majority it is more effective to leverage on its sheer size instead of risking to concede representation to voters from minority-elected districts. However, as the minority becomes larger (closer to a fifty-fifty split), the possibility of losing the whole city induces the majority to prefer minority votes to be confined in minority-packed districts. Single-member district rules serve this purpose. We show empirical results consistent with these implications of the model.

2066. Pol Antras
Incomplete Contracts and the Product Cycle
Abstract | Paper
The incomplete nature of contracts governing international transactions limits the extent to which the production process can be fragmented across borders. In a dynamic, general-equilibrium Ricardian model of North-South trade, the incompleteness of international contracts is shown to lead to the emergence of product cycles. Because of contractual frictions, goods are initially manufactured in the North, where product development takes place. As the good matures and becomes more standardized, the manufacturing stage of production is shifted to the South to benefit from lower wages. Following the property-rights approach to the theory of the firm, the same force that creates product cycles, i.e., incomplete contracts, opens the door to a parallel analysis of the determinants of the mode of organization. The model gives rise to a new version of the product cycle in which manufacturing is shifted to the South first within firm boundaries, and only at a later stage to independent firms in the South. Relative to a world with only arm’s length transacting, allowing for intrafirm production transfer by multinational firms is shown to accelerate the shift of production towards the South, while having an ambiguous effect on relative wages. The model delivers macroeconomic implications that complement the work of Krugman (1979), as well as microeconomic implications consistent with the findings of the empirical literature on the product cycle.

2067. Pol Antras, Luis Garicano and Esteban Rossi-Hansberg
Offshoring in a Knowledge Economy
Abstract | Paper
How does the formation of cross-country teams affect the organization of work and the structure of wages? To study this question we propose a theory of the assignment of heterogeneous agents into hierarchical teams, where less skilled agents specialize in production and more skilled agents specialize in problem solving. We first analyze the properties of the competitive equilibrium of the model in a closed economy, and show that the model has a unique and efficient solution. We then study the equilibrium of two-country model (North and South), where countries differ in their distributions of ability, and in which agents in different countries can join together in teams. We refer to this type of integration as globalization. Globalization leads to better matches for all southern workers but only for the best northern workers. As a result, we show that globalization increases wage inequality in the South but not necessarily in the North. We also study how globalization affects the size distribution of firms and the patterns of consumption and trade in the global economy.

2068.Alberto Alesina, Edward Glaeser and Bruce Sacerdote
Work and Leisure in the U.S. and Europe: Why so Different?
Abstract | Paper
Americans average 25.1 working hours per person in working age per week, but the Germans average 18.6 hours. The average American works 46.2 weeks per year, while the French average 40 weeks per year. Why do western Europeans work so much less than Americans? Recent work argues that these differences result from higher European tax rates, but the vast empirical labor supply literature suggests that tax rates can explain only a small amount of the differences in hours between the U.S. and Europe. Another popular view is that these differences are explained by long-standing European “culture,” but Europeans worked more than Americans as late as the 1960s. In this paper, we argue that European labor market regulations, advocated by unions in declining European industries who argued “work less, work all” explain the bulk of the difference between the U.S. and Europe. These policies do not seem to have increased employment, but they may have had a more society-wide influence on leisure patterns because of a social multiplier where the returns to leisure increase as more people are taking longer vacations.

2069.Nicola Fuchs-Schundeln and Matthias Schundeln
Precautionary Savings and Self-Selection - Evidence from the German Reunification "Experiment"
Abstract | Paper
We combine particular features of the German civil service with the unique event of German reunification to test the theory of precautionary savings and to quantify the importance of self-selection into occupations due to differences in risk aversion. In the presence of self-selection, failing to control for risk aversion in empirical tests of precautionary savings results in a bias that could lead to a false rejection of the theory. We exploit the fact that for individuals from the former German Democratic Republic (GDR) German reunification in 1990 caused an exogenous reassignment of income risks. Our findings suggest that self-selection of risk averse individuals into low-risk occupations is economically important and decreases aggregate precautionary wealth holdings significantly.

2070. Alberto Alesina and George-Marios Angeletos
Corruption, Inequality and Fairness
Abstract | Paper
Bigger governments raise the possibilities for corruption; more corruption may in turn raise the support for redistributive policies that intend to correct the inequality and injustice generated by corruption. We formalize these insights in a simple dynamic model. A positive feedback from past to current levels of taxation and corruption arises either when wealth originating in corruption and rent seeking is considered unfair, or when the ability to engage in corruption is unevenly distributed in the population. This feedback introduces persistence in the size of the government and the levels of corruption and inequality. Multiple steady states exist in some cases.

2071. David M. Cutler, Edward L. Glaeser and Jacob L. Vigdor
Is the Melting Pot Still Hot? Explaining the Resurgence of Immigrant Segregation
Abstract | Paper
This paper uses decennial Census data to examine trends in immigrant segregation in the United States between 1910 and 2000. Immigrant segregation declined in the first half of the century, but has been rising steadily over the past three decades. Analysis of restricted access 1990 Census microdata suggests that this rise would be even more striking if the native-born children of immigrants could be consistently excluded from the analysis. We analyze panel and cross-sectional variation in immigrant segregation, as well as housing price patterns across metropolitan areas, to test four hypotheses of immigrant segregation. Immigration itself has surged in recent decades, but the tendency for newly arrived immigrants to be younger and of lower socioeconomic status explains very little of the recent rise in immigrant segregation. We also find little evidence of increased nativism in the housing market. Evidence instead points to changes in urban form, manifested in particular as native-driven suburbanization and the decline of public transit as a transportation mode, as a central explanation for the new immigrant segregation.

2072. Chris Feige and Jeffrey A. Miron
The Opium Wars, Opium Legalization, and Opium Consumption in China
Abstract | Paper
The effect of drug prohibition on drug consumption is a critical issue in debates over drug policy. One episode that provides information on the consumption-reducing effect of drug prohibition is the Chinese legalization of opium in 1858. In this paper we examine the impact of China's opium legalization on the quantity and price of British opium exports from India to China during the 19th century. We find little evidence that legalization increased exports or decreased price. Thus, the evidence suggests China's opium prohibition had a minimal impact on opium consumpton.

2073. Edward L. Glaeser
Urban Colossus: Why is New York America's Largest City?
Abstract | Paper
New York has been remarkably successful relative to any other large city outside of the sunbelt and it remains the nation’s premier metropolis. What accounts for New York’s rise and continuing success? The rise of New York in the early nineteenth century is the result of technological changes that moved ocean shipping from a point-to-point system to a hub and spoke system; New York’s geography made it the natural hub of this system. Manufacturing then centered in New York because the hub of a transport system is, in many cases, the ideal place to transform raw materials into finished goods. This initial dominance was entrenched by New York’s role as the hub for immigration. In the late 20th century, New York’s survival is based almost entirely on finance and business services, which are also legacies of the port. In this period, New York’s role as a hub still matters, but it is far less important than the edge that density and agglomeration give to the acquisition of knowledge.

2074. Daron Acemoglu, Pol Antras and Elhanan Helpman
Contracts and the Division of Labor
Abstract | Paper
We present a tractable framework for the analysis of the relationship between contract incom- pleteness, technological complementarities and the division of labor. In the model economy, a firm decides the division of labor and contracts with its worker-suppliers on a subset of activities they have to perform. Worker-suppliers choose their investment levels in the remaining activities anticipating the ex post bargaining equilibrium. We show that greater contract incompleteness reduces both the division of labor and the equilibrium level of productivity given the division of labor. The impact of contract incompleteness is greater when the tasks performed by di¤erent workers are more complementary. We also discuss the e¤ect of imperfect credit markets on the division of labor and productivity, and study the choice between the employment relationship versus an organizational form relying on outside contracting. Finally, we derive the implications of our framework for productivity di¤erences and comparative advantage across countries.

2075. Gene M. Grossman and Elhanan Helpman
Party Discipline and Pork-Barrel Politics
Abstract | Paper
Polities differ in the extent to which political parties can pre-commit to carry out promised policy actions if they take power. Commitment problems may arise due to a divergence between the ex ante incentives facing national parties that seek to capture control of the legislature and the ex post incentives facing individual legislators, whose interests may be more parochial. We study how differences in "party discipline" shape fiscal policy choices. In particular, we examine the determinants of national spending on local public goods in a three-stage game of campaign rhetoric, voting, and legislative decision-making. We find that the rhetoric and reality of pork-barrel spending, and also the efficiency of the spending regime, bear a non-monotonic relationship to the degree of party discipline.

2076. Alberto Alesina and Nicola Fuchs-Schundeln
Good bye Lenin (or not?): The effect of Communism on people's preferences
Abstract | Paper
Preferences for redistribution, as well as the generosities of welfare states, differ significantly across countries. In this paper, we test whether there exists a feedback process of the economic regime on individual preferences. We exploit the experiment of German separation and reunification to establish exogeneity of the economic system. From 1945 to 1990, East Germans lived under a Communist regime with heavy state intervention and extensive redistribution. We find that, after German reunification, East Germans are more in favor of redistribution and state intervention than West Germans, even after controlling for economic incentives. This effect is especially strong for older cohorts, who lived under Communism for a longer time period. We find that East Germans’ preferences converge towards those of West Germans, and we calculate that it will take one to two generations for preferences to converge completely.

2077. Harrison Hong, Jeffrey D. Kubik and Jeremy C. Stein
The Only Game in Town: Stock-Price Consequences of Local Bias
Abstract | Paper
Theory suggests that, in the presence of local bias, the price of a stock should be decreasing in the ratio of the aggregate book value of firms in its region to the aggregate risk tolerance of investors in its region. We test this proposition using data on U.S. Census regions and states, and find clear-cut support for it. Most of the variation in the ratio of interest comes from differences across regions in aggregate book value per capita. Regions with low population density—e.g., the Deep South—are home to relatively few firms per capita, which leads to higher stock prices via an “only-game-in-town” effect. This effect is especially pronounced for smaller, less visible firms, where the impact of location on stock prices is roughly 12 percent.

2078. Edward L. Glaeser
Inequality
Abstract | Paper
This paper reviews five striking facts about inequality across countries. As Kuznets (1955) famously first documented, inequality first rises and then falls with income. More unequal societies are much less likely to have democracies or governments that respect property rights. Unequal societies have less redistribution, and we have little idea whether this relationship is caused by redistribution reducing inequality or inequality reducing redistribution. Inequality and ethnic heterogeneity are highly correlated, either because of differences in educational heritages across ethnicities or because ethnic heterogeneity reduces redistribution. Finally, there is much more inequality and less redistribution in the U.S. than in most other developed nations.

2079. Alberto Alesina and Guido Tabellini
Why do Politicians Delegate?
Abstract | Paper
Opportunistic politicians maximize the probability of reelection and rents from office holding. Can it be optimal from their point of view to delegate policy choices to independent bureaucracies? The answer is yes: politicians will delegate some policy tasks, though in general not those that would be socially optimal to delegate. In particular, politicians tend not to delegate coalition forming redistributive policies and policies that create large rents or effective campaign contributions. Instead they prefer to delegate risky policies to shift risk (and blame) on bureaucracies.

2080. John Y. Campbell, Tarun Ramadorai and Tuomo O. Vuolteenaho
Caught On Tape: Institutional Order Flow and Stock Returns
Abstract | Paper
Many questions about institutional trading can only be answered if one can track high-frequency changes in institutional ownership. In the US, however, institutions are only required to report their ownership quarterly in 13-F filings. We infer daily institutional trading behavior from the "tape", the Transactions and Quotes database of the New York Stock Exchange, using both a naive approach and a sophisticated method that best matches quarterly 13-F data. Increases in our measures of institu- tional flows negatively predict returns, particularly when institutions are selling. We interpret this as evidence that 13-F institutions compensate more patient investors for the service of providing liquidity. We also find that both very large and very small trades signal institutional activity, while medium size trades signal activity by the rest of the market.

2081. John Y. Campbell, Jens Hilscher and Jan Szilagyi
In Searach of Distress Risk
Abstract | Paper
This paper explores the determinants of corporate failure and the pricing of financially distressed stocks using US data over the period 1963 to 2003. Firms with higher leverage, lower profitability, lower market capitalization, lower past stock returns, more volatile past stock returns, lower cash holdings, higher market-book ratios, and lower prices per share are more likely to file for bankruptcy, be delisted, or receive a D rating. When predicting failure at longer horizons, the most persistent firm characteristics, market capitalization, the market-book ratio, and equity volatility become relatively more significant. Our model captures much of the time variation in the aggregate failure rate. Since 1981, financially distressed stocks have delivered anomalously low returns. They have lower returns but much higher standard deviations, market betas, and loadings on value and small-cap risk factors than stocks with a low risk of failure. These patterns hold in all size quintiles but are particularly strong in smaller stocks. They are inconsistent with the conjecture that the value and size effects are compensation for the risk of financial distress.

2082. John Y. Campbell, Christopher Polk and Tuomo Vuolteenaho
Growth or Glamour? Fundamentals and Systematic Risk in Stock Returns
Abstract | Paper
The cash flows of growth stocks are particularly sensitive to temporary movements in aggregate stock prices (driven by movements in the equity risk premium), while the cash flows of value stocks are particularly sensitive to permanent movements in aggregate stock prices (driven by market-wide shocks to cash flows.) Thus the high betas of growth stocks with the market's discount-rate shocks, and of value stocks with the market's cash-flow shocks, are determined by the cash-flow fundamentals of growth and value companies. Growth stocks are not merely "glamour stocks" whose systematic risks are purely driven by investor sentiment. More generally, accounting measures of firm-level risk have predictive power for firms' betas with market-wide cash flows, and this predictive power arises from the behavior of firms' cash flows. The systematic risks of stocks with similar accounting characteristics are primarily driven by the systematic risks of their fundamentals.

2083. John Y. Campbell and Joao F. Cocco
How Do House Prices Affect Consumption? Evidence From Micro Data
Abstract | Paper
Housing is a major component of wealth. Since house prices fluctuate considerably over time, it is important to understand how these fluctuations affect households’ consumption decisions. Rising house prices may stimulate consumption by increasing households’ perceived wealth, or by relaxing borrowing constraints. This paper investigates the response of household consumption to house prices using UK micro data. We estimate the largest effect of house prices on consumption for older homeowners, and the smallest effect, insignificantly different from zero, for younger renters. This finding is consistent with heterogeneity in the wealth effect across these groups. In addition, we find that regional house prices affect regional consumption growth. Predictable changes in house prices are correlated with predictable changes in consumption, particularly for households that are more likely to be borrowing constrained, but this effect is driven by national rather than regional house prices and is important for renters as well as homeowners, suggesting that UK house prices are correlated with aggregate financial market conditions.

2084. John Y. Campbell and Samuel B. Thompson
Predicting the Equity Premium Out of Sample: Can Anything Beat the Historical Average?
Abstract | Paper
A number of variables are correlated with subsequent returns on the aggregate US stock market in the 20th Century. Some of these variables are stock market valuation ratios, others reflect patterns in corporate finance or the levels of shortand long-term interest rates. Amit Goyal and Ivo Welch (2004) have argued that in-sample correlations conceal a systematic failure of these variables out of sample: None are able to beat a simple forecast based on the historical average stock return. In this note we show that forecasting variables with significant forecasting power insample generally have a better out-of-sample performance than a forecast based on the historical average return, once sensible restrictions are imposed on the signs of coefficients and return forecasts. The out-of-sample predictive power is small, but we find that it is economically meaningful. We also show that a variable is quite likely to have poor out-of-sample performance for an extended period of time even when the variable genuinely predicts returns with a stable coefficient.

2085. Rustam Ibragimov
On Efficiency of Linear Estimators Under Heavy-Tailedness
Abstract | Paper
The present paper develops a new unified approach to the analysis of efficiency, peakedness and majorization properties of linear estimators. It further studies the robustness of these properties to heavy-tailedness assumptions. the main results show that peakedness and majorization phenomena for random samples from log-concavely distributed populations established in the seminal work by Proschan (1965) continue to hold for not extremely thick- tailed distributions. However, these phenomena are reversed in the case of populations with extremely heavy-tailed densities. Among other results, we show that the sample mean is the best linear unbiased estimator of the population mean for not extremely heavy-tailed populations in the sense of its peakedness properties. Moreover, in such a case, the sample mean exhibits the important property of monotone consistency and, thus, an increase in the sample size always improves its performance. However, as we demonstrate, efficiency of the sample mean in the sense of its peakedness decreases with the sample size if the sample mean is used to estimate the population center under extreme thick-tailedness. We also provide applications of the main efficiency and majorization comparison results in the study of concentration inequalities for linear estimators as well as their extensions to the case of wide classes of dependent data. The main results obtained in the paper provide the basis for the analysis of many problems in a number of other areas, in addition to econometrics and statistics, and, in particular, have applications in the study of robustness of model of firm growth for firms that can invest into information about their markets, value at risk analysis, optimal strategies for a multiproduct monopolist as well that of inheritance models in mathematical evolutionary theory.

2086. Rustam Ibragimov
Portfolio Diversification and Value at Risk Under Thick-Tailedness
Abstract | Paper
We present a unified approach to value at risk analysis under heavy-tailedness using new majorization theory for linear combinations of thick-tailed random variables that we develop. Among other results, we show that the stylized fact that portfolio diversification is always preferable is reversed for extremely heavy-tailed risks or returns. The stylized facts on diversification are nevertheless robust to thick-tailedness of risks or returns as long as their distributions are not extremely long-tailed. We further demonstrate that the value at risk is a coherent measure of risk if distributions of risks are not extremely heavy-tailed. However, coherency of the value at risk is always violated under extreme thick-tailedness. Extensions of the results to the case of dependence, including convolutions of a-symmetric distributions and models with common stochs are provided.

2087. Rustam Ibragimov
Demand-Driven Innovation and Spatial Competition Over Time Under Heavy-Tailed Signals
Abstract | Paper
We study robustness of the model of demand driven innovation and spatial competition over time with log- concavely distributed signals in Jovanovic and Rob (1987) to heavy-tailedness assumptions. We demonstrate that mplications of the model remain valid for not extremely heavy-tailed distributions of consumers' signals. However, ts properties are reversed in the case of signals with extremely thick-tailed distributions if the ¯rms employ the ample mean of the signals to estimate the ideal product. We further show that conclusions of the model continue to hold under the only assumption of symmetry of signals if a more robust estimator of the ideal product, the sample median, is chosen as the product design.

2088. Rustam Ibragimov
Optimal Bundling Strategies For Complements And Substitutes With Heavy-Tailed Valuations
Abstract | Paper
We develop a framework that allows one to model the optimal bundling problem of a multiproduct monopolist providing interrelated goods with an arbitrary degree of complementarity or substitutability. Characterizations of optimal bundling strategies are derived for the seller in the case of long-tailed valuations and tastes for the products. We show, in particular, that if goods provided in a Vickrey auction or any other revenue equivalent auction are substitutes and bidders' tastes for the objects are not extremely heavy-tailed, then the monopolist prefers separate provision of the products. However, if the goods are complements and consumers' tastes are extremely thick- tailed, then the seller prefers providing the products on a single auction. We also present results on consumers' preferences over bundled auctions in the case when their valuations exhibit heavy-tailedness. In addition, we obtain characterizations of optimal bundling strategies for a monopolist who provides complements or substitutes for profit maximizing prices to buyers with long-tailed tastes.

2089. Philippe Aghion, Mathias Dewatripont and Jeremy C. Stein
Academic Freedom, Private-Sector Focus, and the Process of Innovation
Abstract | Paper
We develop a model that clarifies the respective advantages and disad- vantages of academic and private-sector research. Our model assumes full protection of intellectual property rights at all stages of the development process, and hence does not rely on lack of appropriability or spillovers to generate a rationale for academic research. Instead, we focus on control- rights considerations, and argue that the fundamental tradeoff between academia and the private sector is one of creative control versus focus. By serving as a precommitment mechanism that allows scientists to freely pursue their own interests, academia can be indispensable for early-stage research. At the same time, the private sector's ability to direct scientists towards higher-payo¤ activities makes it more attractive for later-stage re- search.

2090. Alberto Alesina and Guido Tabellini
Why is fiscal policy often procyclical?
Abstract | Paper
Many countries, especially developing ones, follow procyclical fiscal polices, namely spending goes up (taxes go down) in booms and spending goes down (taxes go up) in recessions. We provide an explanation for this suboptimal fiscal policy based upon political distortions and incentives for less-than-benevolent government to appropriate rents. Voters have incentives similar to the “starving the Leviathan” classic argument, and demand more public goods or fewer taxes to prevent governments from appropriating rents when the economy is doing well. We test this argument against more traditional explanations based purely on borrowing constraints, with a reasonable amount of success.

2091. Christopher R.Berry and Edward L. Glaeser
The Divergence of Human Capital Levels across Cities
Abstract | Paper
Over the past 30 years, the share of adult populations with college degrees increased more in cities with higher initial schooling levels than in initially less educated places. This tendency appears to be driven by shifts in labor demand as there is an increasing wage premium for skilled people working in skilled cities. In this paper, we present a model where the clustering of skilled people in metropolitan areas is driven by the tendency of skilled entrepreneurs to innovate in ways that employ other skilled people and by the elasticity of housing supply.

2092. Rustam Ibragimov
A Tale of Two Tails: Peakedness Properties in Inheritance Models of Evolutionary Theory
Abstract | Paper
In this paper, we study transmission of traits through generations in multifactorial inheritance models with sex- and time-dependent heritability. We further analyze the implications of these models under heavy-tailedness of traits' distributions. Among other results, we show that in the case of a trait (for instance, a medical or behavioral disorder or a phenotype with significant heritability affecting human capital in an economy) with not very thick-tailed initial density, the trait distribution becomes increasingly more peaked, that is, increasingly more concentrated and unequally spread, with time. But these patterns are reversed for traits with sufficiently heavy-tailed initial distributions (e.g., a medical or behavioral disorder for which there is no strongly expressed risk group or a relatively equally distributed ability with significant genetic influence). Such traits' distributions become less peaked over time and increasingly more spread in the population. In addition, we study the intergenerational transmission of the sex ratio in models of threshold (e.g., polygenic or temperature-dependent) sex determination with long-tailed sex-determining traits. Among other results, we show that if the distribution of the sex determining trait is not very thick-tailed, then several properties of these models are the same as in the case of log-concave densities analyzed by Karlin (1984, 1992). In particular, the excess of males (females) among parents leads to the same pattern for the population of the offspring. Thus, the excess of one sex over the other one accumulates with time and the sex ratio in the total alive population cannot stabilize at the balanced sex ratio value of 1/2. We further show that the above properties are reversed for sufficiently heavy-tailed distributions of sex determining traits. In such settings, the sex ratio of the offspring oscillates around the balanced sex ratio value and an excess of males (females) in the initial period leads to an excess of females (males) offspring next period. Therefore, the sex ratio in the total living population can, in fact, stabilize at 1/2. Interestingly, these results are related, in particular, to the analysis of correlation between human sex ratios and socioeconomic status of parents as well as to the study of the variation of the sex ratio due to parental hormonal levels. The proof of the results in the paper is based on the general results on majorization properties of heavy-tailed distributions obtained recently in Ibragimov (2004) and several their extensions derived in this work.

2093. Eddie Dekel, Drew Fudenberg and Stephen Morris
Topologies on Types
Abstract | Paper
We define and analyze "strategic topologies" on types, under which two types are close if their strategic behavior will be similar in all strategic situations. To oper- ationalize this idea, we adopt interim rationalizability as our solution concept, and define a metric topology on types in the Harsanyi-Mertens-Zamir universal type space. This topology is the coarsest metric topology generating upper and lower hemiconti- nuity of rationalizable outcomes. While upper strategic convergence is equivalent to convergence in the product topology, lower strategic convergence is a strictly stronger requirement, as shown by the electronic mail game. Nonetheless, we show that the set of "finite types" (types describable by finite type spaces) are dense in the lower strategic topology.

2094. Rustam Ibragimov
Copula-Based Dependence Characterizations and Modeling for Time Series
Abstract | Paper
This paper develops a new unified approach to copula-based modeling and characterizations for time series and stochastic processes. We obtain complete characterizations of many time series dependence structures in terms of copulas corresponding to their finite-dimensional distributions. In particular, we focus on copula- based representations for Markov chains of arbitrary order, m-dependent and r-independent time series as well as martingales and conditionally symmetric processes. Our results provide new methods for modeling time series that have prescribed dependence structures such as, for instance, higher order Markov processes as well as non-Markovian processes that nevertheless satisfy Chapman-Kolmogorov stochastic equations. We also focus on the construction and analysis of new classes of copulas that have flexibility to combine many different dependence properties for time series. Among other results, we present a study of new classes of cop- ulas based on expansions by linear functions (Eyraud-Farlie-Gumbel-Mongenstern copulas), power functions (power copulas) and Fourier polynomials (Fourier copulas) and introduce methods for modeling time series using these classes of dependence functions. We also focus on the study of weak convergence of empirical copula processes in the time series context and obtain new results on asymptotic gaussianity of such processes for a wide class of beta mixing sequences.

2095. David H. Autor, Lawrence F. Katz and Melissa S. Kearney
Trends in U.S. Wage Inequality: Re-Assessing the Revisionists
Abstract | Paper
A large literature documents a substantial rise in U.S. wage inequality and educational wage differentials over the past several decades and finds that these trends can be primarily accounted for by shifts in the supply of and demand for skills reinforced by the erosion of labor market institutions affecting the wages of low- and middle-wage workers. Drawing on an additional decade of data, a number of recent contributions reject this consensus to conclude that (1) the rise in wage inequality was an “episodic” event of the first-half of the 1980s rather than a "secular” phenomenon, (2) this rise was largely caused by a falling minimum wage rather than by supply and demand factors; and (3) rising residual wage inequality since the mid-1980s is explained by confounding effects of labor force composition rather than true increases in inequality within detailed demographic groups. We reexamine these claims using detailed data from the Current Population Survey and find only limited support. Although the growth of overall inequality in the U.S. slowed in the 1990s, upper tail inequality rose almost as rapidly during the 1990s as during the 1980s. A decomposition applied to the CPS data reveals large and persistent rise in within-group earnings inequality over the past several decades, controlling for changes in labor force composition. While changes in the minimum wage can potentially account for much of the movement in lower tail earnings inequality, strong time series correlations of the evolution of the real minimum wage and upper tail wage inequality raise questions concerning the causal interpretation of such relationships. We also find that changes in the college/high school wage premium appear to be well captured by standard models emphasizing rapid secular growth in the relative demand for skills and fluctuations in the rate of growth of the relative supply of college workers – though these models do not accurately predict the slowdown in the growth of the college/high-school gap during the 1990s. We conclude that these patterns are not adequately explained by either a ‘unicausal’ skill-biased technical change explanation or a revisionist hypothesis focused primarily on minimum wages and mechanical labor force compositional effects. We speculate that these puzzles can be partially reconciled by a modified version of the skill-biased technical change hypothesis that generates a polarization of skill demands.

2096. David H. Autor, Lawrence F. Katz and Melissa S. Kearney
Rising Wage Inequality: The Role of Composition and Prices
Abstract | Paper
During the early 1980s, earnings inequality in the U.S. labor market rose relatively uniformly throughout the wage distribution. But this uniformity gave way to a significant divergence starting in 1987, with upper-tail (90/50) inequality rising steadily and lower tail (50/10) inequality either flattening or compressing for the next 16 years (1987 to 2003). This paper applies and extends a quantile decomposition technique proposed by Machado and Mata (2005) to evaluate the role of changing labor force composition (in terms of education and experience) and changing labor market prices to the expansion and subsequent divergence of upper- and lower-tail inequality over the last three decades We show that the extended Machado-Mata quantile decomposition corrects shortcomings of the original Juhn-Murphy-Pierce (1993) full distribution accounting method and nests the kernel reweighting approach proposed by DiNardo, Fortin and Lemieux (1996). Our analysis reveals that shifts in labor force composition have positively impacted earnings inequality during the 1990s. But these compositional shifts have primarily operated on the lower half of the earnings distribution by muting a contemporaneous, countervailing lower-tail price compression. The steady rise of upper tail inequality since the late 1970s appears almost entirely explained by ongoing between-group price changes (particularly increasing wage differentials by education) and residual price changes.

2097. Edward L. Glaeser
Paternalism and Psychology
Abstract | Paper
Does bounded rationality make paternalism more attractive? This Essay argues that errors will be larger when suppliers have stronger incentives or lower costs of persuasion and when consumers have weaker incentives to learn the truth. These comparative statics suggest that bounded rationality will often increase the costs of government decisionmaking relative to private decisionmaking, because consumers have better incentives to overcome errors than government decisionmakers, consumers have stronger incentives to choose well when they are purchasing than when they are voting and it is more costly to change the beliefs of millions of consumers than a handful of bureaucrats. As such, recognizing the limits of human cognition may strengthen the case for limited government.

2098. Minyuan Zhao, Kathy Fogel, Randall Morck and Bernard Yeung
Trade Liberalization and Institutional Change
Abstract | Paper
Opening up to global trade and investment is often thought to trigger institutional improvement by raising the expected benefits of institutional reform and reducing incumbents' incentives and ability to preserve the status quo. However, recent experience is not entirely consistent with this conventional wisdom. We suggest an explanation based on variation across countries in firms’ reliance on ambient institutions. Large, well established, or state controlled firms depend less on an economy’s institutions than do small, incipient, or purely private sector firms. Multinational firms likewise can use their global organizations to sidestep weak local institutions. Firm heterogeneity of this sort can thus contribute to markedly different institutional responses to liberalization. Our framework also suggests that institutional development might occur in stages. In an economy whose basic institutions are sound, individuals rationally invest in entrepreneurial capability and firms rationally invest less in institution substitutes. Economies with firms that rely more on ambient institutions or with more potential entrants who would rely on those institutions are more likely to experience further institutional improvement following accession to the global economy. Economies with fewer firms or potential entrants dependent on sound institutions, in acceding to the global economy, may exhibit scant institutional improvement, and perhaps even institutional deterioration. Political rent-seeking is not necessary for the latter outcome, but expands the range of conditions under which it ensues.